Macroeconomic Policy under Market Imperfections

Market economies experience frequent and prolonged fluctuations in economic activity, with recessions following booms. Recessions are of particular concern to the general public and policymakers because they imply underutilization of productive resources, especially in the form of unemployment. Booms, in turn, can create problems of their own, potentially leading to misallocation, an overheated economy, and inflationary pressures. To some extent, these business cycle fluctuations are efficient reactions to changes in economic conditions, such as changes in aggregate productivity. But they can also be the result of insufficient demand or policy mistakes and can be intensified by financial interlinkages, cross-border spillovers, and market imperfections, e.g., labor market frictions or financial frictions. This raises the question as to whether fiscal and/or monetary policy should be used to stabilize business cycle fluctuations.

These questions lie at the heart of the Macroeconomic Policy under Market Imperfections Research Area. We seek to understand what drives business cycle fluctuations, whether these fluctuations are efficient or inefficient, how macroeconomic stabilization policy affects the economy,and whether it should be used to reduce fluctuations in macroeconomic variables. To answer these questions, we draw on a broad range of methods, e.g., using small-scale theoretical models to derive analytical insights, calibrated or estimated DSGE models for simulations, and structural VARs and network analysis for empirical analysis.

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